Soaring inflation has dominated the financial and economic headlines for most of this year. In February, the annual inflation rate reached 7.9%, which was the highest level of inflation in four decades. Every single item in the consumer price index (CPI) went up in price from a year earlier, including gasoline, food, housing and vehicles, both new and used.
Rising inflation and a host of other factors, including increased geopolitical uncertainty, have contributed to higher-than-normal volatility in the financial markets so far this year. After hitting a new record of 36,800 in early January, the Dow Jones Industrial Average plunged to 32,633 just two months later before bouncing back up to 34,565 by mid-March.
Meanwhile, the S&P 500 Index dropped from nearly 4,800 in early January to below 4,200 in early March before rebounding to 4,412 by March 17.
Inflation and the Stock Market
There’s no doubt that rising inflation has spooked the financial markets. But you might be surprised to learn that statistically speaking, inflation has not necessarily had a negative impact on stock market returns during recent history.
According to data compiled by Bloomberg, the annual inflation rate was 2.9% between 1960 and 1972. During this time the S&P 500 Index rose 9% annually, with value stocks rising 12.5% and growth stocks 9.3% annually.
Most people remember the 1970s as the decade of stagflation, a term that was coined during this time to describe rising inflation and slow economic growth occurring at the same time. Even in the midst of this moribund economic environment, the S&P 500 rose 4.7% between 1973 and 1982. Growth stocks rose just 2.1% annually but value stocks rose by double digits, or 10.9%, annually.
Now let’s look at the time period between 1982 and 2008. During this time, the annual inflation rate was 3.2% and the S&P 500 rose by 11.2% annually. The growth rate of value and growth stocks was similar: Value stocks rose by 9.5% while growth stocks rose by 8.5% annually.
More recently, inflation has been relatively tame over the past decade or so. Between 2009 and 2021, the annual inflation rate was just 1.6%. During this time, the S&P 500 rose by 15.2% annually, with value stocks rising by 12.4% and growth stocks rising by 18.4% annually.
So what’s the takeaway here? Simple: The stock market tends to perform well over long periods of time regardless of the inflationary environment. When inflation is high, value stocks usually outperform growth stocks, while just the opposite usually occurs when inflation is low.
It has been a long time since Americans have seen high rates of inflation like we’re seeing today — 40 years, to be exact. Investors and consumers under a certain age have never seen inflation like this, so it’s understandable that many are feeling a little spooked. In fact, the University of Michigan’s Consumer Sentiment Index recently fell to its lowest level in over a decade — even lower than it was during the COVID-19 pandemic.
In addition to inflation, there are many factors that go into falling consumer confidence: rising energy prices, COVID fatigue and the war in Ukraine, to name just a few. Consumer confidence might be able to withstand one or maybe two factors like this, but the convergence of all of them at once is taking its toll.
Maintain a Long-Term Perspective
During times like this, it’s important to take a long-term view of your investments and finances. While past performance is no guarantee of future returns, the statistics above indicate that stock market returns are usually positive over long periods of time.
When things get bumpy like they are now, the best strategy might be to tune out all the “gloom and doom” news headlines and try not to worry about your investment portfolio. Instead, stay focused on your long-term objectives and resist the temptation to make emotional short-term decisions that could jeopardize your financial goals.
We would be happy to talk with you if you have more questions about the potential impact of inflation on your investments.